I occasionally check-in on other personal finance blogs and one that I have read a few times is Million Dollar Journey. In the most recent post the author states that his net worth has increased 10% in 2008. The numbers are all there to support his claim, but if you look closely you see that the majority of the net worth is in property, almost half of the $309,000.
It's very dangerous to claim a personal residence as part of your net worth. Your residence is not a liquid asset. If forced to sell there is no guarantee you would recoup your purchase price. In the market we have today you may not even be able to sell your house. If you do happen to sell the house you have to find a place to live. Whether that be another house or a rental you have to put up some money for that.
To illustrate the danger of including a primary residence in one's net worth let's assume that this couple become unemployed in the next few months. They are in no real danger as they have $62,000 in very liquid assets, but with $265,000 in debt plus living expenses that $62,000 could easily be gone in a year.
This same sort of accounting is found on the balance sheets of every publicly traded company. There are thousands of companies that show a positive net worth because of assets that are not liquid. As the debt piles up the net worth seems to keep up as well, but when we hit a recession like we have today we find that those assets are not worth nearly what was reported when the company files chapter 11.
If you really want to have a good view of your personal net worth you need to divide your assets based on liquidity. Cash is obviously on one end and property (primary residence) is on the other. Retirement accounts fit somewhere in between as they are not worth what's on the paper if withdrawn early. Debt should also be divided into short-term and long-term. A 30-year $300,000 mortgage looks much more cumbersome on a balance sheet than $30,000 in credit card debt at 16.5%, but the credit card debt is much less manageable than the mortgage.
The bottom line is don't be fooled into thinking things are fine because your net worth looks good. All those assets aren't going to mean anything if you can't find somebody to take them off your hands, and nothing decreases prices like a fire-sale.
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1 comment:
Taking it one step further--can a person's net worth really be reduced to a number on a sheet of paper (or a computer screen)?
I think about the net worth of Gordon B. Hinckley, Mother Teresa, even our own grandparents. There's no way that when you totalled all their assets it even came close to the worth that they were to the vast majority of the people that were touched by their lives.
I know, this is a finance blog, and this isn't the line you're going on just now, but I thought I'd give my two cents for the sake of argument, (and to let you know that I do read this blog).
Happy New Year.
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